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Disinvestment in DPSUS – need for more of it

The primary objective of the government in setting up public undertakings was the prosperity of the nation and not making profits.  Disengaging the capital locked up in these undertakings and redeploying it in developmental projects would pay better social and economic dividends in the long run. Therefore, there is a need for evolving a sector-specific policy for disinvestment in DPSUs, which aims at making them more efficient and responsive to the needs of the armed forces.

In February 2017, the government raised Rs 1,600 crore through disinvestment of 5 per cent of the paid-up equity capital out of its share of 74.41 per cent in Bharat Electronic Limited (BEL). The enthusiastic response from investors, both institutional and retail, saw the issue being oversubscribed by 260 per cent. The enthusiasm of the retail investor far exceeded the interest shown by the domestic and foreign investors.

            BEL, a Navratna company is involved in manufacturing of radars and weapon systems, sonars, communication and electronic warfare systems, electro-optics and tank electronics. In the non-defence sector, its product range includes recently-much-in-the-news electronic voting machines, tablet PCs, integrated circuits, hybrid microcircuits, semiconductor devices and solar cells. The company is second only to Hindustan Aeronautics Limited (HAL) among all the DPSU in terms of profit earned since 2012-13. It is a close second to Goa Shipyard Limited (GSL) in terms of the value of exports. In 2015-16, it also exceeded the annual production target. These achievements are probably because BEL has consistently been the highest spender on R&D, even surpassing HAL. During 2016-17, it had spent 10.41 per cent of the total value of production on R&D till December 2016, which is more than the expenditure incurred by all other DPSUs, barring HAL which had spent 7.73 per cent.

Disinvestment Advantage

There are several advantages of disinvestment which could take the form of complete privatisation, strategic disinvestment involving sale of the majority stake, or sale of a minority stake. Since there are serious constraints in raising revenue through taxation, finance ministers often turn to disinvestment as a means of shoring up government's receipts. The objective is not only to reduce the fiscal deficit but also to raise money for development projects which, in turn, stimulates the economy in the long run.

            Disinvestment also fits very well in the present government's policy of least government and maximum governance. Progressive unlocking of the equity blocked in the public undertakings paves the way for greater control of these undertakings by private investors who are more serious about the return on their investment than the government can ever be. Greater control by the private investors leaves the undertakings with no option but to improve their efficiency and productivity to satisfy their shareholders.

Concern and Indicators

Despite these apparent advantages of disinvestment, the overall annual targets have seldom been met. In 2013-14, the government had set a target of Rs 40,000 crore for disinvestment receipts but was able to raise Rs 18,254 crore only. Next year, it was able to raise Rs 32,620 crore against the target of Rs 43,425 crore. It did well in 2015-16 by raising Rs 42,132 crore against the target of Rs 41,000 crore but this was more than offset by zero receipt on account of strategic sale though the government had set a target of Rs 28,500 crore.

            For 2016-17, the target of Rs 36,000 crore for disinvestment receipt has been raised to Rs 40,000 crore in the revised estimates but there has been a sharp decrease in the estimates of receipt on account of strategic disinvestment from Rs 20,500 crore to Rs 5,500 crore. Going by some estimates projected in a section of the media, close to Rs 33,000 crore had been raised by the end of February 2017. If true, the government could again end up falling short of the target. It will also take a lot of doing on the government's part to meet the target of raising Rs 46,500 crores through disinvestment and Rs 15,000 crore through strategic sale during 2017-18.

            These figures show that while the government has been making steady progress in disinvestment, albeit invariably falling short of the target, it has not been a smooth sailing all the way. For one, strategic sales have not picked up at all. This raises the question as to what is coming in the way of meeting the annual disinvestment targets. This question assumes special significance in the context of the DPSUs which are considered strategically too important to be run purely on commercial considerations. Should there be disinvestment in DPSUs? Is there a case for strategic sale of some of them?

            Arguably, the perception that disinvestment only ends up promoting crony capitalism is the biggest hurdle. This is further compounded by the rhetoric that disinvestment is detrimental to the interest of the employees of the undertakings. There are some who may not agree with these perceptions but even they do not consider disinvestment in profit-making undertakings, such as BEL, to be a good idea. Why sell or disinvest in a profit-making enterprise, they would ask. These are fundamental apprehensions that need to be allayed by projecting the positive gains of disinvestment.

            It is true that the penetration of the private households in the equity market is very low in India and, therefore, disinvestment may progressively lead to the private institutional investors and strategic buyers gaining control over a sizeable portion of the equity in the public sector undertakings, depending on the extent of disinvestment. Thus the real benefits of disinvestment may actually not accrue to the retail investor.  The fear is also that the foreign investors could run away with the money whenever they choose to do so, which may have grave repercussions for the DPSUs.

            The overwhelming response from the retail investor to the BEL OFS shows that this segment of the investors is not reluctant to foray into the equity market anymore. Disinvestment through public offerings would, therefore, promote penetration of the retail investor in equities. As for institutional investors, both domestic and foreign, suitable regulatory measures could be put in place to prevent them for any conduct that is detrimental to the defence and security of the country.

            The concerns about welfare of the employees cannot obviously be overlooked but there is no empirical evidence to show that disinvestment is necessarily harmful to their interest. The underlying assumption of welfare-first approach is that the government is a better employer than the private sector. That being the case, there should not be any objection to disinvestment which does not dislodge government from being the majority stake holder. If anything, infusion of private equity is more likely to improve corporate governance which, in turn, would benefit the employees by way of higher wages and bonuses.

            Though in the context of DPSUs, time is perhaps not ripe for strategic sale of any enterprise, barring one or two shipyards, generally speaking even strategic sale is not such a bad idea as often it is made out to be. There is no reason why a strategic buyer cannot be a good employer. The stringent labour laws of the land would require them to comply with the regulatory framework in place. There is also no reason why a strategic buyer would retrench experienced work force en masse.

            The interest of those few who the strategic buyer does not want to retain, or who want to quit on their own, can be protected through a provision in the Shareholders Agreement with the buyer that the benefit under the voluntary retirement scheme (VRS) for the outgoing employees will be equal to, or higher than, the benefits offered by the government under the scheme. Strategic buyers are also more likely to go in for fresh recruitment and pay higher wages as the output of the enterprise picks up.

            The strategic sale of Modern Food Industries (India) Ltd (MFIL) is a case in point. Set up in 1965 as Modern Bakeries (India) Ltd under the Colombo Plan, it became MFIL in 1982. It was the first wholly-owned PSU of the central government to be privatised. In January 2000, the government sold 74 per cent of the stake to Hindustan Lever Limited (HUL).  Later, in November 2002 put option was exercised by the government to sell the remaining stake.

            Post disinvestment, the average wage of the employees increased by Rs 1,600. Though in 2001 HUL approached the Bureau of Industrial and Financial Reconstruction (BIFR), later it took pains to bring it out of BIFR by financing its restructuring.  None of this would have been possible had MFIL remained a government company. Probably, the government would have continued to pump in the tax payers' money for restructuring of the company. (Source: http://www.bsepsu.com/arguments-disinvestment.asp)

Way Forward

But this is an instance of a company that was not doing too well and, therefore, it made some sense for the government to disinvest to avoid having to make further investment to sustain them. This argument does not obviously apply to undertakings that are not a drain on the exchequer and may, in fact, be making profits. By and large, all DPSUs fall in this category (see Table).

Profit by Defence Public Sector Undertakings  (Rs in crore)

DPSU 2012-132013-142014-152015-162016-17*
HAL 2997 2693 2388 1654 1090
BEL 890 932 1167 1358 755.88
BEML -80   5 6.76 52.56 -140.93
BDL 288 346 419 563.24 351.88
GRSE 132 121.46 43.45 160.71 52.87
GSL 16 -61.09 78.24 61.89               70.25
HSL -55 -46.21 -202.84 19                6.15
MDL 413  397.61 491.59 637.82 353.73
MIDHANI 83 83 102.13 118.03 68.53

(Source: Annual report of the Ministry of Defence 2016-17, Chapter VII), *Up to December 2016 (provisional)

            Keeping aside questions about return on the capital employed by the government in these undertakings, there is no doubt that these DPSUs are, by and large, making profits. Why should the government then be disinvesting its stake in them? For one thing, the primary objective of the government in setting up public undertakings was not, and cannot be, to earn profit. Disengaging the capital locked up in these undertakings and redeploying it in developmental projects would pay better social and economic dividends in the long run.

            As a matter of fact, past experience shows that disinvestment could actually result in higher dividends. One such instance is that of profit-making BALCO which, post disinvestment started getting almost sixteen times more dividend than it was getting before that on an average. In the case of CMC and IPCL, the dividend went up fifteen times and nine times respectively after disinvestment. The best example is that of Maruti Udyog Limited, in which case the dividend went up almost twenty times. (Source: http://www.bsepsu.com /arguments-disinvestment.asp)

            But the main argument about the need for disinvestment in the DPSUs is not related to their profitability or even return on the government's investment. Instead, the rationale for disinvestment lies in the need for improving efficiency and the productivity of these undertakings, as also to address the cost and quality concerns. Even partial disinvestment makes an undertaking answerable to thousands of shareholders, instead of it having to pander to the whims of itinerant bureaucrats in the controlling ministries. This is enough to bring about spectacular improvement in performance.

            There is practically no competition in the sectors in which the DPSUs operate, barring shipbuilding to some extent. There is also excessive and non-professional control by the Department of Defence Production. Cost and time over runs are not uncommon, productivity is low, all this is not conducive to optimisation of their capabilities. This, by itself, provides enough justification for disinvestment.

            Going purely by economic considerations the government should be focussing on complete privatisation or strategic disinvestment in some of these DPSUs. There is also a need to withdraw from the non-core areas of production that the ordnance factories are presently engaged in. However, one has to be realistic enough to accept that political compulsions may not permit strategic sale or even disinvestment of a majority stake. Going by the past experience, even corporatisation of the ordnance factories seems virtually impossible. In these circumstances, the government will do well to on the next best option of partial disinvestment with the objective of making these undertakings world-class manufacturing enterprises.

            The objective of improving the productivity and addressing the cost and quality concerns related to products manufactured by DPSUs would not be met if the primary objective of disinvestment is only to raise financial resources to meet the fiscal target. Enough control has to be passed on to the private investors to ensure greater professionalism in running of these undertakings which, in the long run, would also boost the government's revenues. This is not only a commercially desirable proposition but will also bring in cost efficiencies and ensure timely supply of quality products to the Armed Forces.

Summing Up

The overwhelming response to BEL OFS is heartening. Delisting of 10 per cent stake in the state-owned HAL also seems imminent. But, as of now, these measures are a part of the larger government policy on disinvestment. There is a need for evolving a sector-specific policy for disinvestment in DPSUs, which aims at making them more efficient and responsive to the needs of the armed forces. The policy should also address the concerns of the employees, apart from laying down the guidelines to be followed for disinvestment. The disinvestment is going to be a long drawn out process. Perhaps a beginning could be made by listing all the defence companies on the stock exchange. That will do no harm.

(The writer is former Financial Advisory (Acquisition) and Additional Secretary and Member, Defence Procurement Board, MoD.)

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